Cryptic Crypto
A cryptocurrency, crypto for short, is a digital token designed to work as a medium of exchange through a network of computers that is not reliant on any central authority, such as a government or bank, to uphold or maintain it. Today, all financial transactions are verified by a central authority - like a government, bank, or clearing house. Blockchain technology aims to replace this centralised system with a decentralised one, where verification is handled through the consensus of multiple users. A Blockchain is a digitized, distributed, and immutable ledger that records transactions across the network.
Another aspect that makes the technology fascinating is a blockchain’s immutability. Like a ledger, information recorded on a blockchain is encrypted and distributed across the network, which makes it virtually impossible to add, remove or change data without being detected by other users.
A Walk Down Memory Lane
To understand how cryptocurrencies entered mainstream conversations, we need to go back in time to October 2008. A person or a group of people, operating under the pseudonym of Satoshi Nakamoto, published a whitepaper outlining a peer-to-peer version of electronic cash that would allow online payments to be sent directly from one party to another without going through a financial institution. This led to the creation of the first cryptocurrency in history - Bitcoin.
While early adopters like Hal Finney, a software engineer who downloaded the Bitcoin open-source software on its first day of release, and Laszlo Hanyecz, who is the customer that paid BTC 10,000 (worth ~US$ 370 million today) for 2 Papa John’s pizzas, helped establish faith in the currency as a medium of exchange, it wasn’t until February 2011 that Bitcoin was used commercially. The black market platform Silk Road, in its entire 30-month existence, solely accepted Bitcoin as means of payment, transacting BTC 9.9 million, worth about $214 million then ($7.9 trillion today).
However, Bitcoin suffers from various technological challenges, often taking up to 10 minutes to record a transaction on the network. Subsequently launched coins have been engineered to be more efficient and reliant. Vitalik Buterin, in 2013, launched Ethereum, an open-source Blockchain with smart contract functionality, which forms the underlying base for many cryptocurrencies today. Its native cryptocurrency, Ether has a market capitalisation of $318 billion today, second only to Bitcoin, which stands at $700 billion.
The initial rise in crypto paved the path for both ecosystem enablers and malicious actors. We saw crypto exchanges, hedge funds, dedicated venture capital firms being set up and on the other hand witnessed hackers steal millions of dollars from crypto owners, like in 2014, when Japan-based Mt. Gox, the world’s largest Bitcoin exchange announced that approximately BTC 850,000 ($450 million at the time) had been stolen from customers. This was one of the initial catalysts that forced the global authorities to recognise cryptocurrencies. Many countries and central banks banned the ownership of cryptocurrencies altogether or issued whitepapers and regulatory warnings to those who wanted to indulge themselves in this ecosystem.
In 2017, as cryptocurrencies gathered steam, fuelled by FOMO-induced speculators, we saw the first run-up. From April 2017 to January 2018, the global market capitalisation ballooned from US$30 billion to US$785 billion. We started hearing about how cryptocurrencies were the next big thing. Our Uber drivers started explaining Bitcoin to us while our neighbours told us about how they are going to make billions in their friend’s ICO (Initial Coin Offering; a system through which companies raised capital in exchange for issuing tokens which would signify equity or promise of future service). It was a time of exuberance and drew parallels to 2007 when everyone was taking out a mortgage to buy a home. It was a common belief that the housing market would never crash, the music would never stop, till it did. The market capitalisation of cryptocurrencies tumbled to $135 billion in the first half of 2019.
Reminds Us Of Tulips - Why Should We Bother?
Like with any new technology, cryptocurrencies have had their fair share of teething issues. From scams to speculation, they have definitely been through a lot. So, what’s different this time?
Well, for one, cryptocurrencies have been getting a lot of attention from those who matter - governments, central banks, and regulatory authorities. Countries have been looking deeper into the underlying technology, and many of them, have been looking to issue their own digital currencies, also known as Central Bank Digital Currency (CBDC). So far, more than 80 countries including China (Digital Yuan), Russia (CryptoRouble), Sweden (e-Krona), Canada, etc. have launched pilot projects to explore launching their own CBDCs. India, too, announced its plans to issue a Digital Rupee during the 2022 Budget.
More importantly, we have seen real world businesses such as BMW, Whole Foods, Overstock, and Tesla (briefly), either start accepting cryptocurrencies for payments or allocate a part of their treasury to hold cryptocurrencies. We have seen asset management firms such as Grayscale Investments ($32 billion AUM), Galaxy Digital Holdings ($3 billion AUM), etc. pop up, and financial institutions like Goldman Sachs, JP Morgan, Morgan Stanley, UBS, et al. initiate coverage and start building teams to service clients’ needs for trading counterparties and advise.
As more institutions and governments start seeing value in cryptocurrencies, a self-fulfilling prophecy will come true. The value derived from these currencies will be similar to fiat currencies. Think about it - the US Dollar holds value because it is backed by the US Government, an institution the world trusts. Similarly, Bitcoin, Ether, Binance Coin, etc. will hold value as long as the people and institutions have faith in the network to have value.
India and Crypto
India has emerged as one of the fastest-growing hubs for cryptocurrencies. We have 15 cryptoexchanges, of which 2 have achieved ‘Unicorn’ status - CoinSwitch and CoinDCX, and approximately 15 to 20 million people hold US$6 billion worth of cryptocurrencies as of today, compared to the USA, where approximately 23 million people hold cryptocurrencies.
The country has undergone regulatory flip-flops. In 2018, the RBI banned crypto trading in India by ordering banks not to facilitate it. The ban was overturned by the Supreme Court in 2020. Budget 2022 brought about a 30% tax and 1% TDS on all crypto trading gains. While this may seem like a positive sign, we must keep in mind that just because something is taxed does not make it legitimate. In fact, u/s 2(24) of the Income Tax Act, 1961, the legality of the income generated plays no role in determining whether it is taxable or not. Only time will tell whether crypto can whether the regulatory storm in India.
We hope that the latest move by the government shows a willingness to explore legitimisation and regulation of the asset class and that it will take into account the interests of all crypto market participants so that they are not left in the lurch in case of events such as fraud, exchange failures, etc.
So, What’s Next?
We have come a long way from 2018. The global market capitalisation of cryptocurrencies stands at approximately $1.7 trillion, with the top 10 currencies accounting for 79% of the value.
With over 9,300 cryptocurrencies, over 400 cryptoexchanges, and over $70 billion traded daily, we are at an inflection point. The asset class has seen a rapid rise in interest around the world but with new use cases, albeit mostly speculative such as NFT (Non-Fungible Token) transactions, we may very well be en route to having discussions about allocating a small percentage of our entire portfolio to crypto.
Having said that, we are still in the early days. With countries increasingly regulating the asset class, maintaining a track of cryptoholders through taxation, cryptocurrencies may very well lose the utility and features (decentralisation, immutability, and anonymity) that made them popular in the first place. Only time will tell whether crypto, as we know it today, can weather the storm or will central banks and rampant scams lead the asset class to an early grave.